Client Emails
Recap and Outlook
December 29, 2025
Greetings and Happy New Year!
After a volatile start to the year, the S&P 500 will finish the year strong, up double digits for a third consecutive year. Stocks overcame trade tensions and tariff uncertainty and after falling over 18%, moved to record highs fueled by A.I. spending, lower interest rates, a resilient economy and most importantly, strong corporate profits. The bond market rallied this year as well, as credit spreads remained in check and interest rates moved lower. As I write this, the S&P 500 is up over 17% on the year and the U.S. Aggregate Bond index is up over 7%.
I did make some tactical trades in portfolios to take advantage of the "tariff tantrum" earlier in the year. If you recall, back in March and again in April, I increased equity exposure by 10% in moderate to aggressive portfolios. After a roughly 30% move higher, I trimmed exposure to lock in some profits. I still have a slight overweight to equities in general. Within fixed income, I trimmed high yield (lower credit quality) bond exposure and added to investment grade bonds as well as added a position in an alternative asset class that focuses on commodities as well as a low correlation strategy to stocks and bonds.
What did I get right in 2025? Mainly my overweight in Large Growth (technology stocks) and adding exposure to stocks in the depths of the correction when the “experts” were certain we were in for a recession. Until I see evidence of a slowdown in technology spending, I will likely keep a tactical overweight to Large Growth and Technology companies – they are proving to be the most financially stable companies and generating mind boggling amounts of free cash flow. What didn't I get right? Lack of international exposure earlier in the year. Foreign stocks did outperform their U.S. counterparts as valuations had been depressed due to underperformance for several years. I am still not convinced this trend will continue as earnings expectations for U.S. companies is far greater than those in Europe and Asia.
What can we expect in 2026? I have attached LPL Research's summary Outlook for 2026, but If history is any guide, I expect we will see increased volatility for the stock market. Going back to 1950, the stock market, on average, sees an intra-year decline of 14%, even though the average annual gain has been over 10%. According to Bloomberg, in mid-term election years, the drawdown is deeper, averaging 16.7%. Now the good news...the average gain 12 months later has been 36.5%, with markets up 100% of the time. Again, history doesn't always repeat, but it often rhymes. It is important to note that volatility is completely normal, and healthy. According to LPL Research, the interest rate on the benchmark 10-year treasury should remain range bound between 3.75% - 4.25%, allowing bonds to produce low to mid-single digit returns.
According to CNBC, the average estimate for the S&P 500 among Wall Street strategists in 2026 is 7600. That represents a 10% gain from today's levels (a historical average return). What will get us there? There are some potential positive tailwinds that could extend this bull market into its 4th year: 1. Lower interest rates. Stocks (and bonds) tend to do better when interest rates are moving lower. The latest CPI report, although possibly distorted due to the government shutdown, showed inflation continuing to trend lower. Consensus is inflation will continue to contract as shelter costs, the largest component of the CPI, continue to decline. Lower energy prices and the "tariff roll-off" should also help keep inflation tame. If inflation does indeed continue to trend lower, the FED will likely continue to lower interest rates. It is also no secret that the next Federal Reserve Chairman, appointed by President Trump in May, will be a strong proponent of lower interest rates. 2. Fiscal stimulus. The Big Beautiful Bill was signed into law in 2025 and according to the U.S. Treasury, could increase tax refunds by up to $150 billion that could provide a boost in consumer spending. Consumer spending is over 60% of our economy. We may also see a boost in U.S. corporate spending as the tax bill’s changes in depreciation and amortization will likely boost new business investment and capital spending. 3. Earnings growth. U.S. corporate profits will likely have grown close to 15% in 2025 and average analyst expectations are for 13%-14% S&P 500 earnings growth in 2026. Technology is expected to have the strongest growth (again) at over 25%, according to LPL Research. Earnings growth will likely be fueled by continued spending on A.I. and productivity gains as a result of the technology’s adoption. I think this is the third year I have been talking about the A.I. spend and increased productivity (higher profit margins) gains. Dan Niles, a very well-respected tech investor believes we are still in the early stages of this A.I. driven boom, noting the internet build out and investment in the 1990’s took over six years.
Despite the overall bullishness heading into 2026, risks still remain. We are facing another possible government shutdown the end of January. The Supreme Court will be ruling on the legality of the Trump tariffs and fears are if they are deemed "illegal" a potential refund of those tariffs could cause short-term uncertainty for markets. As noted earlier, the mid-term elections could cause market volatility and any unexpected increase in inflation and/or interest rates could derail the bull market. Heightened earnings growth expectations could prove to be a slight risk if companies do not deliver results. Analysts have underestimated the earning growth of U.S. companies for the last few years. I am hoping they underestimated profits once again. But overall, I am fairly optimistic for 2026 – at this point, the positives are outweighing the potential negatives.
As always, I will be closely monitoring the markets and economy and will make any changes I feel necessary to portfolios.
Please let me know if you have any questions and have a Happy and Health New Year!
Regards,
Larry